Monday, October 8, 2007

A few weeks ago, we started some discussion about what we've called The Great Dane Dilemma. For the uninitiated or formalistic, the definition of "dilemma" is: "state of uncertainty or perplexity especially as requiring a choice between equally unfavorable options." A more appropriate word does not exist in the English language.

The "state of uncertainty or perplexity" is embodied in Senate Bill 224. It is instructive, however, to look at the current state of affairs that has instigated the design of SB 224. At the end of prohibition, laws were put into place that would protect small brewers in the retail marketplace. There was a legitimate fear that the larger breweries such as Miller, Pabst, and Schlitz would oligopolize the Wisconsin beer market by saturating the state with tied houses.

In order to protect consumers from a consolidated market, the Wisconsin Legislature passed the law that is currently in effect. This law prevented breweries from creating "tied houses" but allowed a small number of "brew pubs." The distinction is technical, but important. At a "tied house" beer is not brewed on premises, but the restaurant only serves beer from one source. At a "brew pub" the beer is brewed on premises and sold at that location. There is also an exception to the "tied house" law that allows small breweries, defined as a producer of less than 4,000 barrels, to have a limited number "tied houses."

This all comes together with The Great Dane because The Great Dane has reached the "brew pub" limit, they have two. The current law would allow The Great Dane to distribute from those two brew pubs to their third location at Hilldale under the small brewer exception to tied houses, if The Great Dane stays below the 4,000 barrel limit. If they exceed that limit, they would have to sell their own beer to an independent distributor, suffer the 30% mark-up, then buy it back. As it currently operates, The Great Dane is over the 4,000 barrel limit because of its brew pub operations and outside distribution; The Great Dane sells to distributors and its beer can be found at various bars around the city.

Thus, on the one hand, we have unfavorable option number one: the law stays the same and The Great Dane is unable to supply its Hilldale location without going through an independent distributor while maintaining its two brew pubs and continuing to distribute outside of its own establishments. Why is this an unfavorable option? Primarily because it is not in accordance with the purpose behind the law. Recall, that the purpose was to prevent market saturation by big breweries. Clearly, The Great Dane is not a "big brewery." Three brew pubs and a nominal amount of distribution in the Madison area is far from market saturation. Yet, the law is preventing exactly the sort of entrepreneurship and craft brewing that should be encouraged.

It would be folly to note just The Great Dane because there are a lot of great brewpubs in this state that would be unable to expand. The Milwaukee Ale House, for example, is looking at further expansion.

On the other had, we have unfavorable option number two: Senate Bill 224. SB 224 changes the rules regarding how breweries and brewpubs co-exist. Under the current rules, a brewery can hold a Class B license for up to 2 facilities, regardless of how many barrels the brewery produces. A Class B license allows the brewer to sell fermented malt beverages (beer) for consumption on premises. If the brewer is "small" (under 4,000 barrels a year), it can distribute to up to four locations. And, a brewery can hold a restaurant permit. So, a brewery like Tyranena can sell its beer and operate a restaurant at its brewery because it has a Class B license and could acquire a restaurant permit. If it wanted, it could open a second location with a restaurant and Class B license.

SB 224 changes the brewery/brewpub dynamic and sets out distinctions between being a brewery and being a brewpub. Breweries must adhere strictly to the three-tier distribution (brewery, distributor, retailer), while brewpubs do not. However, the trade-off is that a "brewpub" is very narrowly defined and one cannot be both a brewery and a brewpub. And, SB 224 prohibits a brewery from holding a restaurant permits; if the brewery wants to serve food and beer, it must qualify as a brewpub.

So, what does it take to be a brewpub under SB 224? Well, first, the brewery must produce less than 10,000 barrels per year. This would rule out all but the very smallest Wisconsin breweries. Thus, breweries such as Tyranena, Grays, New Glarus, Capital, Viking, South Shore, and Lakefront would all be prohibited from operating restaurants on their premises; something all of them can do, if they desire, under the current law. Second, the brewpub must brew everything on premises; this is not really much of an issue, but does act to prohibit "tied houses" (Gray's Tied House in Verona is not, despite its name, a true tied house because it brews on premises) and would prevent a situation like at Granite City where part of the brewing process is performed off-site and some of it is performed on-site. The brewpub must operate a restaurant where food sales account for at least 40% of all sales. This is a tricky provision because it requires that each location have sales of food over 40%; thus, it would foreclose a brewpub operating a bottling brewery where they happen to serve some food. It would also prevent small breweries from utilizing restaurant operations as another income stream until beer revenues stabilize. For an example, consider Ale Asylum on Madison's East Side: food does not account for 40% of their total revenue because it is primarily a brewery, but without the food, income streams might be scarce or unstable. Ale Asylum, under SB 224 as it is currently written, would not qualify as a brewpub and thus would be foreclosed from serving food at the brewery.

Next, in addition to the above requirements for a brewpub license, the brewpub must also hold a Class B license and sell beer manufactured by others. This provision is very clearly a distributor protection clause. The distributors want to make sure that every restaurant or pub in the state has to purchase something from them. And, the final requirement of significance is that the brewpub cannot hold a Class A license, a brewer's permit, or warehousing or distribution permits. You will recall that a Class A license allows the breweries to sell (in quantity) bottled beer for consumption off-premises. Again, this provision is very clearly distibutor protectionism, as it prevents any small-time competition to the three-tier distribution system. Presumably, the fear is that if all of the brewpubs could sell bottles and warehouse at their facilities, consumers could just go straight to the source instead of driving down the beer store which is supplied by the distributors.

What SB 224 represents then is an attempt to distinguish between breweries, which can only distribute through the three-tier system, and a very narrow exception to the three-tier system for brewpubs. If a brewer meets the brewpub requirements, it can hold up to six brewpubs in the state.

SB 224 carves out a niche for brewpubs and it does a great job of that. It would allow reasonable expansion by brewpubs. And, believe it or not, would allow brewpubs to bottle up to 1000 additional barrels, on top of the 10,000 barrels the brewpub permit allows, for retail sale. So, this is a great law for brewpubs. Or at least until they want to exceed the 10,000 barrel limit or want a seventh location.

We called it "unfavorable" a little bit ago, and you can probably start to see why some see SB 224 as an unfavorable law. Brewers are forced to choose between being a brewpub and being a brewery. One cannot be both under SB 224. Thus, it forecloses income streams that small breweries take advantage of. For example, Grays would be unable to open Grays Tied House. Ale Asylum could not have their wonderful premises. Tyranena would not be able to run a restaurant at its facility. This income stream is not only surplus income, but it generates tremendous amounts of goodwill for the breweries and craft-brewing in general.

This has been an in-depth look at what SB 224 accomplishes. We aren't judging whether this is "good" or "bad" for the industry. We've merely noted that it changes how the industry currently works and in what ways the industry will be impacted. As for judging this bill, we will have two interviews in the coming days (Wednesday and Friday): an interview with Rob Larson, owner and brewer at Tyranena Brewing Company in Lake Mills, WI; and, an interview with Eliot Butler, co-owner and business manager of The Great Dane. They both have some really great insight on SB 224 and its impact on their brewing facilities, and the industry in general.